UNDERSTANDING GOODWILL
and LENDING RISK CALCULATION METHODS

 

Goodwill -  Meaning - Understanding - Valuing.

GOODWILL 8 PAGES COPYRIGHT (c) J. TRAVERS 1994
GOODWILL DESCRIPTION PAGES 1 TO 4 see below
GOODWILL ASSESSMENT PAGES 5 TO 8 Enquiries to above address.

UNDERSTANDING GOODWILL

and LENDING RISK CALCULATION METHODS

AUTHOR: JIM TRAVERS

A few years ago as an employee of a very large business broking firm, I found there were fifty five salesmen with fifty five different methods of assessing Goodwill values.

Following discussions with Partners of many of Adelaide's leading accounting firms, apart from applying text book rules, each had their own theories based on a few experiences.

I decided to examine the subject. Accountants text books quoted five basis where financial applications of Goodwill could be applied.

The most popular are:-

1. Net tangible assets adjusted for current values.
2. Dividend return, based on expected percentage return on investment.
3. Capitalisation of maintainable profits.

None of the basis covered recessions, abnormal bad debts or businesses starting with newly developed inventions. There are many areas of dispute where accountants and business managers disagree on goodwill valuations. Until there is a basis of valuation that accounts for every facet of Goodwill, Business Brokers, Financial Lenders, Accountants, Managers, Vendors and Purchasers will remain in a tangled web of disagreement.

As a Business Broker I found the subject of Goodwill became a daily conflict.

I decided to research the meaning of goodwill as defined by Legal Court decisions.

The Adelaide Supreme Court, the University Law Department and the Canberra Federal Court libraries provided me with every court case back to the 1700's for Australia, New Zealand, United Kingdom, India, Canada and USA. Based on numerous goodwill court case decisions, I put together the most common strains and then sought opinions of my Paper by a Librarian, Chartered Accountant, Agricultural Scientist, lawyer and Economics Lecturer before publishing it.

GOODWILL

Quote: "Goodwill is the very sap and life of the business without which the business
would yield little or no fruit ... "

It has the characteristics of cement which binds together or unites the other assets of the business into a cohesive whole.
Goodwill is the benefit and advantage of:

a) good name
b) reputation
c) connection of a business

It is the difference between a new business on its first day and old established business.
Goodwill composition differs in different trades and different businesses in the same trade.
One element may stand out here and another there. It is the attraction force that brings business.
Commercial goodwill grows out of all kinds of PAST EFFORT in:

a) Seeking profit
b) Increasing value
c) Other advantages.

It may or may not have exchangeable value. The exchangeable value of the commercial goodwill depends upon the probability of future earnings, ie. The amount by which

1) Revenue
2) Increase of value
3) Other advantages received exceeds any and all economic expenditure such as labour and capital incidental to its production. Without probability of future earnings no present value in goodwill can exist.

Goodwill may be described as representing the capitalised value of actual or prospective "Super Earnings".

To determine the nature of Goodwill in any given case it is necessary to consider the type of business and the customer which such a business is inherently likely to attract as well as all the surrounding circumstances.

(Acknowledgement, the established principles of the concept of goodwill are universally known and applied in various forms.)

Having written a most comprehensive description of goodwill based on court cases worldwide I discovered the key words for valuing goodwill - they are:

PAST EFFORT WITH FUTURE RETURN
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Badwill has been mentioned in a number of court cases. Badwill is:

NO EFFORT WITH REDUCTION IN FUTURE RETURN

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Potential is often confused with goodwill. Potential is:

MINIMAL EFFORT WITH FUTURE RETURN

GOODWILL expresses in one word a "SUMMARY" of the Past Efforts with Future Returns of a business entity.

GOODWILL "TRIFORMS" (Manifests into three) GROUPS

GROUP A For Universal Users
Past Efforts that are multi-dividable and transferable.

GROUP B For Twin Users
Past Efforts that are mono-dividable and transferable.

GROUP C For single use of original business
Past Efforts that are NON-dividable and NON-transferable.

SEGMENTS

SEGMENT A Intellectual property. Property possessing a high level of understanding or intelligence
Includes: patents, copyrights, production design drawings, software computer programs.

SEGMENT B Commercial proprietorship.
Includes: past efforts that have made or saved money and will continue to do so frequently in the future.

SEGMENT C Conceptual Proprietorship.
Includes: Past efforts to develop designs, schemes, plans of action etc that will bring about future returns.

GOODWILL is a "SUMMARY" of Past Efforts with Future Returns.

It is made up of numerous groups, segments and headings. To value a "SUMMARY" it has to be broken up into its many divisions before each can be costed with reasonable accuracy. The same divisions can each be assessed for individual lending risk rate percentages.

Set out below is a table of lending risk rate percentages to allow against one hundred percentage points of each assessed divisional component.
 
LENDING RATE TABLE
FOR GOODWILL SUMMARY GROUPS AND SEGMENTS
AGAINST DEMONSTRATED CALCULATED VALUES OF EACH HEADING

	SEGMENTS
	A INTELLECTUAL PROPERTY	B COMMERCIAL PROPRIETORSHIP	C CONCEPTUAL PROPRIETORSHIP
GROUP A FOR UNIVERSAL USERS MULTI DIVIDABLE & TRANSFERABLE	50 PERCENT	45 PERCENT	40 PERCENT
GROUP B FOR TWIN USERS MONO DIVIDABLE & TRANSFERABLE	40 PERCENT	35 PERCENT	30 PERCENT
GROUP C FOR SINGLE USE OF ORIGINAL BUSINESS  NON DIVIDABLE NON TRANSFERABLE	30 PERCENT	25 PERCENT	10 PERCENT

VALUING GOODWILL

To prepare the demonstrated calculated value of the business entity's Goodwill. One hundred and forty past effort headings are listed (refer to above address)
Against each applicable past effort heading the owner must assess a calculated monetary value.

a) Justify it?
b) Explain how they think they will earn a return on each past effort?
c) How long would it take for an owner to pay it off?
d) Will each past effort lose its value before it is paid off?